The Payment Of Freight Differential Under Letters Of Credit
The unit price of the crude oil cargoes sold on CIF basis is based on a standard destination which is the trading hub for the geographical area where the cargo is to be delivered. For instance, the Russian crude oil cargoes shipped at the Black Sea port of Novorossiysk to be sold on CIF basis in the Mediterranean region are priced on CIF Augusta basis.
If the CIF buyers request delivery of cargo to other port than Augusta, e.g. Genova, the price of cargo shall be adjusted by the freight differential calculated as the difference between the charter party freight rate for the tanker voyage between the port of loading (Novorossiysk) and the nominated port of discharge (Genova) and the charter party freight rate for the tanker voyage between the port of loading (Novorossiysk) and the port of Augusta, as in the example shown below:
The freight rate of tanker voyage charter party is expressed as a percentage of current Worldscale1 rate ranging from 1 to 1000% in function of the market level of freight rates at the date of charter party. WS flat rate is stated as WS 100. WS 109 would mean 109 percent of the Worldscale rate. WS 75 would mean 75 percent of the Worldscale rate.
Assuming that the charter party freight rate for a tanker voyage between Novorossiysk and Augusta is WS 75 and WS rate is US $ 10 per metric ton, then the charter party freight rate will be US $ 7.5 per metric ton2.
Next it is calculated the freight rate for the tanker voyage between Novorossiysk and Genova, taking into consideration the WS rate for such voyage. Assuming a WS rate of US $ 11 per metric ton, the freight rate will be US $ 8.25 per metric ton (that is, 75% of WS rate). That gives a freight rate differential of US $ 0.75 per metric ton.
The freight differential is calculated taking into consideration the Bill of Lading quantity in gross metric tonnes based on which the freight is calculated and the charter party overage freight rate3 which is typically 50% of the charter party freight rate.
Most crude oil cargoes shipped at Novorossiysk for Mediterranean region are cargoes of 80,000 metric tonnes. In case of a cargo of, let`s say, 84,402 metric tonnes, the freight differential shall be calculated first for the quantity of 80,000 metric tonnes and then for the quantity in excess of 80,000 metric tonnes.
The freight differential shall be calculated for the quantity of 80,000 metric tonnes shall be calculated as follows:
80,000 MT x 0.75 (freight rate differential) x 0.75 (charter party freight rate expressed as a percentage from WS flat rate) = 45,000 USD
The freight differential for the quantity of 4,402 metric tonnes shall be calculated as follows:
4,402 MT x 0.75 (freight rate differential) x 0.375 (charter party overage freight rate expressed as a percentage from WS rate) = 1,238.06 USD
That gives a total of 46,238.06 USD. That`s the freight differential.
The CIF sellers state the amount of freight differential in the commercial invoice under the price of cargo calculated based on the standard destination and then state the total price of cargo. The commercial invoices issued for CIF cargoes have an attachment showing the freight differential calculations and are presented for payment along with the ship fixture note (voyage charter party), as an evidence of the freight rate and overage freight rate.
The problem with the payment of freight differential under letters of credit is that the banks` letter of credit officers do not check the freight differential calculations nor the voyage charter party terms stating the freight rate and overage freight rate on the grounds that the ICC rules for documentary credits and guidelines for the examination of documents under documentary credits provide that the banks are not responsible to check the mathematical calculations and charter party terms4. This leaves open the possibility for the CIF sellers to overcharge the amount of freight differential and get the money from the bank.
by Vlad Cioarec, International Trade Consultant
This article has been published in Commoditylaw`s Oil Trade Review Edition No. 2.
Endnotes:
1. The New Worldwide Tanker Nominal Freight Scale.
2. The freight rate shall be calculated based on the WS rate current on the date of commencement of loading of the vessel in question.
3. Freight for the cargo loaded in excess of the minimum quantity agreed in charter party.
4. Article 22(b) of UCP600 provides that: “A bank will not examine charter party contracts, even if they are required to be presented by the terms of the credit.”